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Howmet (HWM) Research Report: Q1 CY2024 Update


Full Report / June 03, 2024

Aerospace and defense company Howmet (NYSE:HWM) beat analysts' expectations in Q1 CY2024, with revenue up 13.8% year on year to $1.82 billion. It made a non-GAAP profit of $0.57 per share, improving from its profit of $0.42 per share in the same quarter last year.

Howmet (HWM) Q1 CY2024 Highlights:

  • Revenue: $1.82 billion vs analyst estimates of $1.74 billion (5.1% beat)
  • EPS (non-GAAP): $0.57 vs analyst estimates of $0.52 (9.8% beat)
  • Gross Margin (GAAP): 29.3%, up from 27.6% in the same quarter last year
  • Free Cash Flow of $95 million, down 76.4% from the previous quarter
  • Market Capitalization: $34.55 billion

Inventing the first forged aluminum truck wheel, Howmet (NYSE:HWM) specializes in lightweight metals engineering and manufacturing multi-material components used in vehicles.

Howmet is most commonly known for its engineering of engine products, structural aircraft components, and forged wheels. The company also provides research and development services in support of new technology such as the production of lightweight alloys for aerospace applications.

Howmet primarily sells its products to the commercial aerospace market, while also gaining sales from defense contractors and original equipment manufacturers (OEM). Customers use Howmet’s specialized multi-material components, such as airframes and wheels, in the production of air and ground vehicles. Services such as maintenance and repair are commonly coupled with product sales.

Howmet secures long-term contracts for components and services with defense contractors and OEMs like Boeing through direct negotiation. Joint ventures and collaborative research with partners facilitate new markets. Third-party distributors and agents are utilized to facilitate sales outside of the U.S.

Aerospace

Aerospace companies often possess technical expertise and have made significant capital investments to produce complex products. It is an industry where innovation is important, and lately, emissions and automation are in focus, so companies that boast advances in these areas can take market share. On the other hand, demand for aerospace products can ebb and flow with economic cycles and geopolitical tensions, which can be particularly painful for companies with high fixed costs.

Howmet’s competitors include Boeing (NYSE:BA), Lockheed Martin (NYSE:LMT), and TransDigm (NYSE:TDG)

Sales Growth

Examining a company's long-term performance can provide clues about its business quality. Any business can put up a good quarter or two, but the best consistently grow over the long haul. Over the last five years, Howmet's revenue declined at a 11.1% annual rate. This shows its demand was weak and its business shrunk, making for rough starting point in our quality assessment. Howmet Total Revenue

Long-term growth is the most important, but within industrials, a half-decade historical view may miss new industry trends or demand cycles. Howmet's annualized revenue growth of 16.1% over the last two years is above its five-year trend, suggesting its demand has recently accelerated.

We can better understand the company's revenue dynamics by analyzing its most important segments, Engine products and Fastening systems, which are 48.5% and 21.3% of revenue. Over the last two years, Howmet's Engine products revenue (aircraft engines, industrial turbines) averaged 18.9% year-on-year growth while its Fastening systems revenue (connector products and tools) averaged 17.4% growth.

This quarter, Howmet reported robust year-on-year revenue growth of 13.8%, and its $1.82 billion of revenue exceeded Wall Street's estimates by 5.1%. Looking ahead, Wall Street expects sales to grow 6.2% over the next 12 months, a deceleration from this quarter.

Operating Margin

Howmet has been an efficient company over the last five years. It demonstrated it can be one of the more profitable businesses in the industrials sector, boasting an average operating margin of 14.2%.

Analyzing the trend in its profitability, Howmet's annual operating margin rose by 9.8 percentage points over the last five years. Its growth shows it's one of the better Aerospace companies as most peers saw their margins plummet.

Howmet Operating Margin (GAAP)

This quarter, Howmet generated an operating profit margin of 20.2%, up 2.5 percentage points year on year.

EPS

Analyzing long-term revenue trends tells us about a company's historical growth, but the long-term change in its earnings per share (EPS) points to the profitability of that growth–for example, a company could inflate its sales through excessive spending on advertising and promotions.

Howmet's EPS grew at a decent 9.2% compounded annual growth rate over the last five years, higher than its 11.1% annualized revenue declines. This tells us management adapted its cost structure in response to a challenging demand environment.

Howmet EPS (Adjusted)

We can take a deeper look into Howmet's earnings quality to better understand the drivers of its performance. As we mentioned earlier, Howmet's operating margin expanded by 9.8 percentage points over the last five years. On top of that, its share count shrank by 14%. These are positive signs for shareholders because improving profitability and share buybacks turbocharge EPS growth relative to revenue growth.

Like with revenue, we also analyze EPS over a shorter period to see if we are missing a change in the business. For Howmet, its two-year annual EPS growth of 34.6% was higher than its five-year trend. This acceleration made it one of the faster-growing industrials companies in recent history.

In Q1, Howmet reported EPS at $0.57, up from $0.42 in the same quarter last year. This print beat analysts' estimates by 9.8%. Over the next 12 months, Wall Street expects Howmet to grow its earnings. Analysts are projecting its EPS of $2 in the last year to climb by 15.4% to $2.31.

Cash Is King

If you've followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can't use accounting profits to pay the bills.

Howmet has shown mediocre cash profitability over the last five years, putting it in a pinch as it gives the company limited opportunities to reinvest, pay down debt, or return capital to shareholders. Its free cash flow margin averaged 5.2%, subpar for an industrials business. The divergence from its good operating margin stems from its capital-intensive business model, which requires Howmet to make cash investments in working capital (i.e., stocking inventories) and capital expenditures (i.e., building new facilities).

Taking a step back, an encouraging sign is that Howmet's margin expanded by 13.6 percentage points during that time. The company's improvement shows it's heading in the right direction.

Howmet Free Cash Flow Margin

Howmet's free cash flow clocked in at $95 million in Q1, equivalent to a 5.2% margin. This quarter's result was nice as its cash flow turned positive after being negative in the same quarter last year, but we wouldn't put too much weight on it because businesses' working capital needs can be seasonal, causing quarter-to-quarter swings.

Return on Invested Capital (ROIC)

EPS and free cash flow tell us whether a company was profitable while growing its revenue. But was its growth capital-efficient? Enter ROIC, a metric showing how much operating profit a company generates relative to how much money it has raised (debt and equity).

Although Howmet has shown solid business quality lately, it historically did a mediocre job investing in profitable business initiatives. Its five-year average ROIC was 9.1%, somewhat low compared to the best industrials companies that consistently pump out 20%+.

Howmet Return On Invested Capital

The trend in its ROIC, however, is often what surprises the market and moves the stock price. Over the last few years, Howmet's ROIC averaged 3.1 percentage point increases each year. The company's rising ROIC is a good sign and could suggest its competitive advantage or profitable business opportunities are expanding.

Balance Sheet Risk

As long-term investors, the risk we care most about is the permanent loss of capital. This can happen when a company goes bankrupt or raises money from a disadvantaged position and is separate from short-term stock price volatility, which we are much less bothered by.

Howmet reported $533 million of cash and $3.69 billion of debt on its balance sheet in the most recent quarter. As investors in high-quality companies, we primarily focus on two things: 1) that a company's debt level isn't too high and 2) that its interest payments are not excessively burdening the business.

With $1.59 billion of EBITDA over the last 12 months, we view Howmet's 2.0x net-debt-to-EBITDA ratio as safe. We also see its $94 million of annual interest expenses as appropriate. The company's profits give it plenty of breathing room, allowing it to continue investing in new initiatives.

Key Takeaways from Howmet's Q1 Results

We were impressed by how significantly Howmet blew past analysts' operating margin expectations this quarter. We were also excited its revenue outperformed Wall Street's estimates. Zooming out, we think this was an impressive quarter that should delight shareholders. The stock is flat after reporting and currently trades at $84.22 per share.

Is Now The Time?

Howmet may have had a good quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.

There are several reasons why we think Howmet is a great business. Although its revenue has declined over the last five years, its growth over the next 12 months is expected to be higher. And while its mediocre ROIC suggests it has grown profits at a slow pace historically, its rising cash profitability gives it more optionality. On top of that, its operating margin expansion shows the business has become more efficient.

Howmet's price-to-earnings ratio based on the next 12 months is 36.7x. Looking at the industrials landscape today, Howmet's qualities stand out, and there's no doubt it's a bit of a market darling. We'd argue that it's often wise to hold high-quality businesses over the long term (even if expectations are high), but we do note there is a lot of optimism priced in at the moment.

Wall Street analysts covering the company had a one-year price target of $71.65 right before these results (compared to the current share price of $84.22).

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